Both traditional and non-traditional, or alternative, reinsurance capital have been growing strongly, but in 2013 alternative capital grew by a massive 28% to end the year at a record $50 billion, according to broker Aon Benfield.
Growth of alternative reinsurance capital in 2013, so capital allocated to insurance linked investments in catastrophe bonds, collateralized reinsurance and other insurance-linked securities (ILS), helped the total level of reinsurance capital to grow by 7% in 2013 to a record $540 billion, according to Aon Benfield.

The ‘transformative impact’ of alternative capital flowing into the reinsurance industry is continuing to benefit reinsurance buyers, said Aon Benfield. The importance of alternative capital in reinsurance and the lower-cost associated with efficient capital from institutional investors has now fully sunk in and traditional reinsurers are using it to reduce the costs of their own capacity.

Aon Benfield said in its April 1st Reinsurance Market Outlook report; “Traditional reinsurers have begun to employ the alternative capital flows to enhance their value propositions and match the price points available directly from funds that have not developed relationships with cedents.”

This trend is not really new, reinsurers have been using and managing third-party capital in vehicles such as sidecars and other quota shares for years, what is different is the amount of reinsurers employing this strategy in 2014, with almost all the major players leveraging third-party capital to some degree.

Reinsurers are attempting to match the very competitive pricing offered by some capital markets players and ILS funds, playing them at their own game by leveraging third-party capital to reduce their own cost of underwriting capital, to be able to compete on even terms.

“While the traditional reinsurance market has only begun its transformation, it is clear that it will match the new lower disaggregated (diversifying) price-points of alternative investors,” explained Aon Benfield.

As traditional reinsurers seek to lower the cost of their underwriting capacity through the use of alternative capital the question is whether they will be able to command the same margins as before when they were underwriting on their own equity backed funds.

Once again, it is worth reiterating that this trend if not managed intelligently in-house at reinsurers could result in some increases to expense ratios in quarterly results to come. Margin erosion, from selling product at price levels which don’t cover costs sufficiently to maintain operational efficiency, is not a advised and can become a slippery slope so reinsurers beware.

As reinsurers continue to compete aggressively, lowering cost-of-capital, relaxing terms and conditions and offering multi-year contracts, the risk is that diligence suffers and some firms become at risk of over-exposure when events occur or market conditions change.

For buyers, the impact is positive and it means that the high pricing paid historically for peak peril reinsurance cover may be a thing of the past and the future may look more competitively priced and with a more flattened reinsurance cycle, without the peaks and troughs seen previously.

Aon Benfield said; “Reinsurance buyers are now able to imagine a future where very heavy margin loadings for peak zones may not be part of the long-term future.”

Reinsurance buyers benefited at the April reinsurance renewals, as record levels of both traditional and alternative capital continued to pressure pricing and terms. Aon Benfield says that this trend is expected to continue at the next major reinsurance renewals in June and July, where ceding companies and buyers are expected to realise further savings.

Japanese renewals, which make up much of the activity in April, saw improved pricing and abundant capacity available. With the Tohoku earthquake now three years in the past reinsurers provided capacity at improved pricing and alternative capital maintained a presence in Japanese earthquake risk.

U.S. renewals in April, which are limited in number, also saw abundant capacity and continued improvement on contractual terms, said Aon Benfield. Relaxed hours clauses, more favorable reinstatement terms and improved rates were seen in the U.S. while the UK witnessed similar renewals.

According to Aon Benfield global reinsurer capital, the brokers measure which includes both traditional and alternative reinsurance capital available to trade risk with, rose by 7% to $540 billion at the end of 2013.

Alternative reinsurance capital saw strong growth during the year, as investor appetite for insurance and reinsurance linked investments continued to grow, ending 2013 with $50 billion of capital in the collateralized and ILS market, up by 28% during the year from the $39 billion seen at the end of 2012.

The $540 billion of global reinsurance capital is the highest number ever seen and has grown by a massive 60% since the end of 2008, according to Aon Benfield.

During 2013, growth in traditional reinsurance capital was driven by low catastrophe loss activity and reserve releases lifting reinsurer income. Alternative capital rose to make up just over 9% of total reinsurer capital by the end of the year with the influx of new funds from capital market investors continuing to drive the growth of the alternative sector.

Change in global reinsurance capital - Source: Aon Benfield

Combined ratios, as measured for the Aon Benfield Aggregate group of reinsurers, showed a small but continued improvement, the broker said, ending the year at 89.6%. catastrophe loss activity creates the most volatility in combined ratios, and 2013 saw the lowest contribution to combined ratio since 2009 at just 4.7%.

Perhaps most interestingly the expense ratios of the reinsurers tracked by the Aon Benfield Aggregate rose slightly, reaching their highest contribution to combined ratios in recent years. It will be extremely interesting to watch where this measurement of expense ratios goes later this year as reinsurers cannot afford to increase expenses while cutting margins due to reduced pricing.

Global insurer capital also grew in 2013, with the total rising by 4% to end the year with $3.66 trillion of capital attributed to global insurance companies. Once again, the low-level of catastrophe losses contributed to insurer capital increases, particularly in North America and Asia-Pacific.

Aon Benfield’s report echoes many of the comments made by other market observers, in recent weeks. Pricing pressure continues, alternative capital in reinsurance continues to grow, reinsurers are fighting back aggressively with relaxed terms and lower prices and this is all set to continue as we approach the important mid-year reinsurance renewals.

With reinsurers now using more alternative capital to lower the cost of their own underwriting capital opportunities for investors to access insurance and reinsurance linked investments look set to increase even while pricing remains on the wane. That should see the amount of alternative capital in the global reinsurance market continue to increase.

The real impact of this ‘transformative effect’ that alternative capital is having on reinsurance will begin to emerge later this year, once we have seen the pricing trajectory from the mid-year renewals and traditional reinsurers report third and fourth quarter results.